Sunday, January 25, 2009

The following comes from a reader, Adam Rafalovich. It's an interesting, if extremely downbeat take on the US economy, its recent past, and its coming future. I am doing a few other things at the moment, so I will give it a response in the morning. For context, he is responding to my take on the economist Kenneth Rogoff's call to deliberately inflate the dollar as a way out of the current mess. Yikes!

From Dr. Rafalovich:

Very solid points! Let me offer some additional comments:

The primary problem with the perhaps trillion dollar economic stimulus is its HIGHLY inflationary nature. To fund this stimulus requires the offering of even more US debt and a possible collapse of the US dollar. Embarking upon this stimulus (in addition to the TARP funds—half of which have been used, the other half, who knows?) risks serious usurpation of individual buying power and, of course, individual wealth. Who is to guarantee that other countries are going to keep the US dollar around as a reserve currency? What is the saturation point for those who hold US debt?

While I agree that something has to be done, if the post-stimulus economy does not "grow its way" out of this massive debt-issuance hurdle we might be in Argentinean, even Weimar Germany territory.

With that rather ominous statement let me state what I think is going on with the US economy:

I believe that we are BEGINNING (I laugh when economists predict the end of the recession in the middle of this year!!) a protracted period of economic restructuring. We may call this a recession, depression, whatever. The reality is that the level of consumer indebtedness in the US that gave the middle class the illusion of wealth for the last 25 years (thank you Mr. Reagan and Mr. Greenspan!) will come down drastically. We have now come to the end of easy revolving credit and the “house as ATM machine” refinancing craze. There will NOT be a resurgence of the US consumer sans a war, or some other consolidation of US economic power. The US consumer is done, and that is that.

Home prices are so far out of whack with median income, we still need an additional 20-30% correction in the housing market for people to afford homes again. Difficult-to-attain credit, job losses, and stagnate or declining real wages are all viciously feeding into this housing market correction. Also, let me add here that the fact that this whole thing “began” with the housing implosion and therefore must be corrected through a revitalization of housing really underscores the fundamental problem here in the US: HOUSING IS ALL WE HAVE!

Discard the drivel from the “Big Three” auto manufacturers that have provided a case study in outsourcing and do not have near the economic importance that they had a generation ago.

Discard the 1990s neo-liberal lie that we now live in a “new economy” where we can “sell” knowledge.

Finally, discard the idea that developing nations have “decoupled” from the US in this great experiment of global capitalism. When we cough, the UK gets the flu, India gets small pox, and China gets bubonic plague. And, right now, the US economy is in intensive care!

Again, the problem is that we don’t make anything in this country anymore. Neo-liberal policies have forced us to move all of our eggs into the housing basket, which has become a source of wages (through housing-related jobs), consumer spending (through tapping home equity lines of credit), and retirement (through paying a hefty mortgage, selling one’s house and moving someplace cheaper). This is the primary reason for Bernanke’s lowering of the federal funds rate and target rate, and the reason that the US government (that is, with a little help from our tax money!) is now engaging in the unprecedented and dangerous process of buying mortgage backed securities. The idea is that if you make money easier to get and mortgages more safe, mortgage rates will go down, which is exactly what they have done. But this misses a fundamental problem: artificially inflating asset prices is unsustainable and this will ultimately come home to roost, not with the wealthy, but with wage-earning, middle-income families.

Because housing is all we have, if we allow this correction to move through its natural course, you will see individual balance sheets virtually destroyed. The Fed cannot let that happen because that would necessitate an even great stimulus, the issuance of even larger amounts of US debt, and a further weakening of our currency.

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